Market bears alive and well

Wall Street cheered the Fannie-Freddie bailout. But some think the optimism was overdone. Here's how they're trying to profit from more doom and gloom.

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By Paul R. La Monica, editor at large

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NEW YORK ( -- The markets surged Monday as investors giddily bought stocks in the wake of the bailout of Fannie Mae and Freddie Mac.

Yesterday, I explained the reasons why Wall Street cheered the news and and why the rescue may one day mark the end of the bear market.

Many of this column's readers begged to differ. In fact, those who commented on the Talkback page overwhelmingly shared the belief that the worst is not over.

So what if the bears are right? I speak to a lot of experts who are not as optimistic as I am, and today I'm throwing a bone to all of you out there who love to hate me and think I'm nothing more than a Pollyanna (but please keep reading and posting!).

The case for more pain

Investors are putting a lot of faith in Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke and their ability to end the credit crunch.

But there was similar thinking back in March after the Fed helped engineer the "rescue" of Bear Stearns. Six months later, it's clear many were too optimistic and some think the latest bounce is just a sucker's rally.

"This is a Bear Stearns moment. I think the market goes back down once people realize this won't solve all the problems," said Jeffrey Saut, chief market strategist with Raymond James.

"I can't help but have the image of Ben Bernanke and Henry Paulson running around sticking their fingers in dikes only to have another leak spring up somewhere else," Saut added.

He's far from being the only one with that view.

Steve Lehman, manager of the Federated Market Opportunity fund, a hybrid fund with about $1.8 billion in assets that makes both long and short bets, said that the takeover of Fannie and Freddie will do nothing to change what's likely to be a weak second-half for both corporate profits and the economy.

"The fundamental news will be pretty bad in terms of earnings. Economic numbers are highly unreliable and I think there will be significant revisions downward later in the year. This is not the beginning of a big move up," Lehman said.

And Gary Wollin, who runs a wealth management firm in San Francisco, said that in particular, consumer spending is likely to be weak as the combination of higher food and gas prices and the continued sluggishness in housing take their toll.

"Unless something changes quickly, we are going to have a really bad Christmas," he said. "Maybe the Fannie-Freddie bailout stops the bleeding in housing a tad but nothing's really changed. I think it gets worse from here and stock prices will go down even more."

What the bears are doing

All that said, these three still think there are ways for investors to profit from all this doom and gloom.

Saut said he's mostly recommending stocks that pay big dividends in industries that are somewhat safer such as energy and telecom as opposed to high-yielding banks that are likely to slash their dividends to preserve cash.

He likes long-distance firm Embarq (EQ, Fortune 500), formerly part of Sprint, and natural gas company Linn Energy (LINE). Embarq's dividend yields 6.1% and Linn has a yield of 12.5%. Both companies have boosted their payouts in the past year.

"In a market like this, yields will pay a huge part of your total return," Saut said.

Lehman, whose long-short trading strategy has enabled his fund to weather this financial turmoil - it's relatively unchanged since the bear market officially began last October compared to a nearly 20% drop in the S&P 500 - said he's shorting exchange-traded funds (ETFs) that focus on techs, financials, small caps and emerging markets.

He thinks earnings estimates are still too high for the tech and financial sectors as well as small caps and that valuations for stocks in emerging markets are too rich.

But Lehman is finding some stocks that he likes. He believes that gold stocks, despite a pullback that's left the metal trading at below $800 an ounce, are good hedges against inflation and negative real interest rates in the United States.

Miners Barrick Gold (ABX), Yamana Gold (AUY) and Kinross Gold (KGC) are all top holdings in his portfolio. He even owns some healthcare stocks as a defensive move, including drug maker Sepracor (SEPR) and genetic testing company Affymetrix (AFFX).

However, Lehman stressed that with the markets so volatile, now is not a good time to take many long-term bets. He thinks investors should quickly lock in any gains if they can.

"This is a bear market. Buy and hold is not an appropriate strategy. You need to have more of a trading orientation," he said.

Finally, Wollin said he's not ready to buy anything just yet but that he's starting to look for some possible value plays. He described himself as less of a bear than someone who is "a bull that's been bearish for a year."

Wollin doesn't recommend shorting anything but said his portfolio now has a pretty heavy weighting - about 30% in cash. He, like Saut, said that he's most interested in dividend-paying stocks.

As such, he said he's considering buying high-yielders AT&T (T, Fortune 500), Packaging Corp. of America (PKG) and Bristol-Myers Squibb (BMY, Fortune 500) but that it's too soon to pull the trigger on any of these stocks.

So what's he waiting for? Either a bigger market pullback or real evidence that the economy is ready to rebound.

"The market would have to go lower or something exceptional would have to happen that would give me the sense that worst was over. I don't think Fannie and Freddie was it," Wollin said.

He added that he'd feel comfortable buying stocks if the Dow went back down to about 10,500. That's about 9% below the Dow's current level and would represent a new low for this bear market.

What do you think? Could the Dow head to 10,500 or even lower in the next few months or is it more likely to climb back towards 13,000? Let us know on our Talkback pageTo top of page

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